What is home equity?
Home equity is the portion of your home that you’ve paid off. It’s the difference between what the home is worth and how much is still owed on your mortgage. For many, equity from homeownership is a great way to build personal wealth over time. As your home’s value increases over the long term and you pay down the principal on the mortgage, your equity grows.
Home equity can be used for big expenses and often represents a more cost-effective financing option than credit cards or personal loans with high-interest rates.
How home equity works
The most common ways to access the equity in your home are either a HELOC or a home equity loan/cash-out refinance. My last blog was on cash-out refinance which is one way to use the equity in your home. If you need a lump sum then a home equity loan could be a way to go. Or if you’d like to borrow against your home equity, a credit line, a HELOC (home equity line of credit) could help you meet your financial goals.
A home equity loan comes with fixed payments and a fixed interest rate for the term of the loan. Home equity loans give the borrower a lump sum upfront, and in return, they must make fixed payments over the life of the loan.
HELOCs are revolving credit lines that come with variable interest rates and, as a result, variable minimum payment amounts. HELOCs allow a borrower to tap into their equity as needed up to a certain preset credit limit. HELOCs have a variable interest rate, and the payments are not usually fixed.
Why use home equity?
Tapping your home equity can be a convenient, low-cost way to borrow large sums at favorable interest rates to pay for:
- Home improvements
- College costs
- Debt consolidation
- Emergency expenses
- Wedding expenses
- Business expenses
However, the right type of loan depends on your needs and what you plan to use the money for.
The value of your home can decline
Keep in mind that there’s no guarantee that your home value will increase substantially over time. Your home may even lose value in times of economic downturn or suffer damage from fire or extreme weather. However, real estate is historically a great investment and your equity should replenish within a few years.
There’s a limit to how much you can borrow
There’s also a limit to the amount you can borrow on a HELOC or home equity loan. To determine how much money you’re eligible for, lenders will calculate your loan-to-value ratio, or LTV. Even if you have $300,000 in equity, the majority of lenders will not let you borrow that much money.
Lenders generally allow homeowners to borrow up to 80 percent of the value of their homes, minus existing mortgage balances. That number can be different from person to person, though, and depends heavily on your credit score, financial history and current income.
Run the numbers and ensure that you can continue paying your regular mortgage on top of a new home equity loan and that you have a solid plan for improving your finances with home equity money.
This can be confusing, so, please feel free to contact me and I can answer any questions you may have. And I can also put you in touch with my preferred lender.
Beth Brake REALTOR® 214-769-2947
Positively impacting your life as you move toward your dreams.